International Capital Budgeting

Transcription

1 INERNAIONAL FINANCIAL MANAGEMEN Fourh Ediion EUN / RENICK Inernaional Capial Budgeing 8 Chaper Eigheen INERNAIONAL Chaper Objecive: FINANCIAL MANAGEMEN his chaper discusses he mehodology ha a mulinaional firm can use o analyze he Fourh Ediion invesmen of capial in a foreign counry. EUN / RENICK 8-8- Chaper Ouline Review of Domesic Capial Budgeing Review of Domesic Capial Budgeing he Adjused Presen Value Model Capial Budgeing from he Paren Firm s Perspecive Risk Adjusmen in he Capial Budgeing Process ensiiviy Analysis Real Opions 8-. Idenify he IZE and IMING of all relevan cash flows on a ime line.. Idenify he RIKINE of he cash flows o deermine he appropriae discoun rae.. Find NPV by discouning he cash flows a he appropriae discoun rae. 4. Compare he value of compeing cash flow sreams a he same poin in ime Review of Domesic Capial Budgeing he basic ne presen value equaion is CF V NPV = C = ( K ) ( K) Where: CF = expeced incremenal afer-ax cash flow in year, V = expeced afer ax erminal value including reurn of ne working capial, C = iniial invesmen a incepion, K = weighed average cos of capial. = economic life of he projec in years. 8-5 Review of Domesic Capial Budgeing he NPV rule is o accep a projec if NPV CF V NPV = C ( K) ( K ) = and o rejec a projec if NPV CF V NPV = C ( K) ( K ) =.

2 Review of Domesic Capial Budgeing For our purposes i is necessary o expand he NPV equaion. CF = (R OC D I )( τ) D I ( τ) R is incremenal revenue OC is incremenal operaing cash flow D is incremenal depreciaion I is incremenal ineres expense τ is he marginal ax rae Alernaive Formulaions CF CF = (R OC D I )( τ) D I ( τ) CF = (NI D I ( τ) CF = (R OC D ( τ) D CF = (NOI )( τ) D CF = (R OC )( τ) τ D CF = (OCF )( τ) τ D Review of Domesic Capial Budgeing We can use CF = (OCF )( τ) τ D o resae he NPV equaion CF NPV = V C = ( K) ( K) as: NPV = (OCF )( τ) τ D V C = ( K) ( K) he Adjused Presen Value Model NPV = (OCF )( τ) τ D V = C ( K) ( K) = ( K) Can be convered o adjused presen value (APV) (OCF )( τ) = ( K u ) τ D τ I V C ( i) ( i) ( Ku ) By appealing o Modigliani and Miller s resuls he Adjused Presen Value Model (OCF )( τ) = ( K u ) τ D τ I V C ( i) ( i) ( K u ) he APV model is a value addiiviy approach o capial budgeing. Each cash flow ha is a source of value o he firm is considered individually. Noe ha wih he APV model, each cash flow is discouned a a rae ha is appropriae o he riskiness of he cash flow. Domesic APV Example Consider his projec, he iming and size of he incremenal afer-ax cash flows for an all-equiy firm are: -$, $5 $5 $75 $5 4 CF = $ he unlevered cos of equiy is r = %: he projec would be rejeced by CF = $5 an all-equiy firm: CF = $5 CF = $5 I = NPV = $

3 Domesic APV Example (coninued) Now, imagine ha he firm finances he projec wih $6 of deb a r = 8%. he ax rae is 4%, so hey have an ineres ax shield worh τ I =.4 $6.8 = $9. each year. 8- $ $, $5 $5 $75 $5 4 he APV of he projec under leverage is: (OCF )( τ) = ( K u ) τ D τ I V C ( i) ( i) ( K u ) $5 (.) $75 (.) $5 (.) 4 $9. $9. (.8) $9. $9. $,.8 (.8) (.8) 4 $7.9 he firm should accep he projec if i finances wih deb. Capial Budgeing from he Paren Firm s Perspecive (OCF )( τ) = ( K u ) τ D τ I V C ( i) ( i) ( K u ) he APV model is useful for a domesic firm analyzing a domesic capial expendiure or for a foreign subsidiary of a MNC analyzing a proposed capial expendiure from he subsidiary s viewpoin. he APV model is NO useful for a MNC in analyzing a foreign capial expendiure from he paren firm s perspecive. 8-4 Capial Budgeing from he Paren Firm s Perspecive Donald Lessard developed an APV model for a MNC analyzing a foreign capial expendiure. he model recognizes many of he pariculars peculiar o foreign direc invesmen. 8-5 = V ( K ) ud OCF ( ) ( K ) C ud = D ( i ) RF CL d = = ( i ) I ( i ) d d Capial Budgeing from he Paren Firm s Perspecive OCF ( τ) = ( K ud ) τ D τ I = ( i d ) = ( i d ) V ( K ud ) C RF CL = ( i d ) OCF ( τ) = ( K ud ) V ( K ud ) C RF CL he operaing cash flows mus be ranslaed back ino he paren firm s currency a he spo rae expeced o prevail in each period. τ D τ I = ( i d ) = ( i d ) = ( i d ) he operaing cash flows mus be discouned a he unlevered domesic rae

4 Capial Budgeing from he Paren Firm s Perspecive OCF ( τ) = ( K ud ) V ( K ud ) C RF CL OCF represens only he porion of operaing cash flows available for remiance ha can be legally remied o he paren firm. τ D τ I = ( i d ) = ( i d ) = ( i d ) he marginal corporae ax rae, τ, is he larger of he paren s or foreign subsidiary s. Capial Budgeing from he Paren Firm s Perspecive OCF ( τ) = ( K ud ) V ( K ud ) C RF CL = ( i d ) RF represens he value of accumulaed resriced funds (in he amoun of RF ) ha are freed up by he projec. τ D τ I = ( i d ) = ( i d ) Denoes he presen value (in he paren s currency) of any concessionary loans, CL, and loan paymens,, discouned a i d Capial Budgeing from he Paren Firm s Perspecive One recipe for inernaional decision makers:. Esimae fuure cash flows in foreign currency.. Conver o he home currency a he prediced exchange rae. Use PPP, IRP e ceera for he predicions.. Calculae NPV using he home currency cos of capial. Capial Budgeing from he Paren Firm s Perspecive: Example A U..-based MNC is considering a European opporuniy. I s a simple example here is no incremenal deb here is no incremenal depreciaion here are no concessionary loans here are no resriced funds 8-8- Capial Budgeing from he Paren Firm s Perspecive: Example We can use a simplified APV: OCF ( τ) = ( K ud ) OCF ( τ) C = ( K ud ) 8- τ D τ I = ( i d ) = ( i d ) V ( K ud ) C RF CL = ( i d ) Capial Budgeing from he Paren Firm s Perspecive: Example A U.. MNC is considering a European opporuniy. he size and iming of he afer-ax cash flows are: he inflaion rae in he euro zone is π = %, he inflaion rae in dollars is π $ = 6%, and he business risk of he invesmen would lead an unlevered U.. based firm o demand a reurn of K ud = i $ = 5%

5 Capial Budgeing from he Paren Firm s Perspecive: Example Is his a good invesmen from he perspecive of he U.. shareholders? o address ha quesion, le s conver all of he cash flows o dollars and hen find he NPV a i $ = 5% $.5 he curren exchange rae is ($/) = Capial Budgeing from he Paren Firm s Perspecive: Example 8-5 $ CF = (6) ($/) =(6) $.5 = $75 Finding he dollar value of he iniial cash $.5 flow is easy; conver a he spo rae: ($/) = Capial Budgeing from he Paren Firm s Perspecive: Example $75 $ he exchange rae expeced o prevail in he firs year, ($/), can be found wih PPP: π $.6 $.5 ($/) = π ($/) =. = $.864/ Capial Budgeing from he Paren Firm s Perspecive: Example $75 $ $ $.5 CF = 5 = $ CF = ($/) = $.864/ = $ Capial Budgeing from he Paren Firm s Perspecive: Example $75 $ $ $ $.5 CF = = $ Capial Budgeing from he Paren Firm s Perspecive: Example $75 $57.8 $66.94 $48.7 Find he NPV using he cash flow menu of your financial calculaor and and ineres rae i $ = 5%: CF = $75 CF = $57.8 CF = $66.94 CF = $48.7 I = 5 NPV = $

6 Capial Budgeing from he Paren Firm s Perspecive: Example $75 $57.8 $57.8 NPV = $75.5 $66.94 $66.94 (.5) $48.7 Wihou a financial calculaor, he NPV can be found as: $48.7 = $4.99 (.5) Capial Budgeing from he Paren Firm s Perspecive: Alernaive Anoher recipe for inernaional decision makers:. Esimae fuure cash flows in foreign currency.. Esimae he foreign currency discoun rae.. Calculae he foreign currency NPV using he foreign cos of capial. 4. ranslae he foreign currency NPV ino dollars using he spo exchange rae Foreign Currency Cos of Capial Mehod 6 5 π Le s find i and use ha on he euro = % cash flows o find he NPV in euros. i $ = 5% hen ranslae he NPV ino dollars a π $ = 6% he spo rae. $.5 he curren exchange rae is ($/) = 8- Foreign Currency Cos of Capial Mehod Before we find i le s use our inuiion. ince he euro-zone inflaion rae is % lower han he dollar inflaion rae, our euro denominaed discoun rae should be lower han our dollar denominaed discoun rae. Finding he Foreign Currency Cos of Capial: i Recall ha he Fisher Effec holds ha ( e) ( π $ ) = ( i $ ) real rae inflaion rae nominal rae Finding he Foreign Currency Cos of Capial: i If Fisher Effec holds here and abroad hen ( e $ ) = ( i $ ) ( π $ ) ( e ) = ( i ) ( π ) If he real raes are he same in dollars and euros (e = e $ ) o for example he real rae in he U.. mus be 8.49% we have a very useful pariy condiion: ( e) = ( i $ ) e =.5 ( π $ ).6 =.849 ( i $ ) = ( i ) ( π $ ) ( π ) and

7 Finding he Foreign Currency Cos of Capial: i If we have any hree of hese variables, we can find he fourh: ( i $ ) ( π $ ) = ( i ) ( π ) In our example, we wan o find i ( i ) = ( i $ ) ( π ) ( π $ ) 8-6 (.5) (.) i = (.6) i = Inernaional Capial Budgeing: Example 6 Find he NPV using he cash flow menu and i =.75%: CF = 6 CF = CF = 5 CF = 5 I =.75 NPV = 94.9 $ = $4.99 Capial Budgeing from he Paren Firm s Perspecive: Example Wihou a financial calculaor, he NPV can be found as: NPV = = 94.9 (.75) (.75) $ = $ Inernaional Capial Budgeing You have wo equally valid approaches: Change he foreign cash flows ino dollars a he exchange raes expeced o prevail. Find he $NPV using he dollar cos of capial. Find he foreign currency NPV using he foreign currency cos of capial. ranslae ha ino dollars a he spo exchange rae. If you wach your rounding, you will ge exacly he same answer eiher way. Which mehod you prefer is your choice. 8-4 Back o he full APV Using he inuiion jus developed, we can modify Lessard s APV model as shown above, if we find i convenien. OCF ( τ) τ D = τ I ( K ud ) = ( i d ) = ( i d ) f f f f V ( K ud ) C RF CL ( i d ) = f Copyrigh 7 by he McGraw-Hill Companies, Inc. All righs reserved. 8-4 Risk Adjusmen in he Capial Budgeing Process Clearly risk and reurn are correlaed. Poliical risk may exis along side of business risk, necessiaing an adjusmen in he discoun rae.

8 ensiiviy Analysis Real Opions In he APV model, each cash flow has a probabiliy disribuion associaed wih i. Hence, he realized value may be differen from wha was expeced. In sensiiviy analysis, differen esimaes are used for expeced inflaion raes, cos and pricing esimaes, and oher inpus for he APV o give he manager a more complee picure of he planned capial invesmen. 8-4 he applicaion of opions pricing heory o he evaluaion of invesmen opions in real projecs is known as real opions. A iming opion is an opion on when o make he invesmen. A growh opion is an opion o increase he scale of he invesmen. A suspension opion is an opion o emporarily cease producion. An abandonmen opion is an opion o qui he invesmen early. 8-4 Value of he Opion o Delay: Example Value of he Opion o Delay: Example A French firm is considering a one-year invesmen in he Unied Kingdom wih a pound-denominaed rae of reurn of 5%. he firm s local cos of capial is i = % he cash flows are 8-44,,5 he curren exchange rae is ( ) =. uppose ha he bank of England is considering eiher ighening or loosening is moneary policy. I is widely believed ha in one year here are only wo possibiliies: ( ) =. per ( ) =.8 per Following revaluaion, he exchange rae is expeced o remain seady for a leas anoher year Opion o Delay: Example If ( ) =.8 per he projec will have urned ou o be a loser for he French firm:,,7 If ( ) =. per he projec will have urned ou o be a winner for he French firm:,,5 IRR =.5% IRR = 6.5% Opion o Delay: Example An imporan hing o noice is ha here is an imporan source of risk (exchange rae risk) ha isn incorporaed ino he French firm s local cos of capial of i = %. ha s why here are no NPV esimaes on he las slide. Even wih ha, we can see ha aking he projec on oday enails a win big lose big gamble on exchange raes. Analogous o buying an a -he-money call opion on Briish pounds wih a mauriy of one year

9 Opion o Delay: Example he remaining slides assume a knowledge of he maerial conained in chaper 7. Especially he noion of a replicaing porfolio. Bu also basic hings like a call opions gives he holder he righ o buy a specific asse a a specific price for a specific amoun of ime. Opion o Delay: Example he payoff in one year of porfolio consising of an a -hemoney call opion wrien on, plus a risk-free bond wih a fuure value of,7 equals he payoff of he Briish invesmen: ( )./ Briish Invesmen,5 = Bond Call Opion =,7 46 Replicaing = Porfolio =,5.8/,7 =,7 =, Opion o Delay: Example Opion o Delay: Example o he presen value of he projec a ime zero can be found by geing a quoe from an opion dealer on an a-he-money call on, and adding o ha he presen value of,7 a he euro-zone risk-free rae. he Ne Presen Value of he projec is ha sum less he cos of he projec,,: 8-5 uppose ha our opion dealer quoes an opion premium of.5 per pound and our banker quoes he euro-zone risk-free rae a i = 6%. he NPV of he projec a ime zero o he French firm is 8-5 NPV =, 5,7.6 = 67.8 Before we accep a posiive NPV projec, we should make sure ha we are no bypassing alernaive projecs wih NPV =, value of opion,7 higher NPVs. i Waiing a year o sar he same projec is an alernaive. Opion o Delay: Example Do he Righ hing If he firm can wai a year o sar he projec he cash flows look like If ( ) =.8 per 8-5,8,7 IRR = 5% NPV = 8.8 =,8,7. If ( ) =. per,,5 IRR = 5% NPV = We have a choice: o inves in he projec oday or o wai a year. If we jump in oday, he NPV is 67.8 and he FV in one year is NPV = 74.6 = Clearly i s beer o wai a year. Wors case, NPV = 8.8 and here is a chance ha he NPV a ime one is Boh of hese oucomes bea

10 End Chaper Eigheen 8-54